A trap for the unwary – option grants to not ordinarily resident employees

UK companies sometimes grant share options to employees who are resident but not ordinarily resident in the UK at the date of grant. These are usually employees who live outside the UK and are seconded from the overseas subsidiary to work for the UK parent company for a short period of time (six months would be long enough to make them UK resident but not ordinarily resident).

There are two areas which employers need to watch out for. The first concerns the incidence of a UK income tax charge arising on the grant of an option and the second, the ability to transfer employer’s NIC in relation to options, restricted securities and convertible securities.

Tax charge arising on the grant of an option

Where an option is granted to an employee who is UK resident but not ordinarily resident on the date of grant, a charge to UK income tax may arise on the grant of the option if that option is granted at less than market value. This is because the statutory exemption which would alleviate an income tax charge on grant of the option, contained in section 475 Income Tax (Earnings & Pensions) Act 2003 (“ITEPA 2003”), only applies to options granted to employees who are UK resident and ordinarily resident at the date of grant (with minor exceptions). Where the exemption applies, the tax charge is delayed until the date of exercise, i.e. when value is realised by the optionholder.

Generally speaking, for employees who are neither UK resident or UK ordinarily resident at the date of grant of the option, the tax charge is delayed until the date of exercise.

However where an individual who is UK resident but not ordinarily resident is granted a “nil-cost” option or an option with an exercise price at less than the market value of the shares on the date of grant, an income tax charge will arise on the date of grant under section 62 ITEPA2003 on general Abbott v Philbin principles.

As a matter of policy, there does not seem to be any reason why employees who are resident but not ordinarily resident at the time of grant should be treated differently. Any gain realised on exercise would be fully subject to tax (although, in the case of not UK ordinarily resident employees, this would be under the notional loan provisions in Chapter 3C Part 7 ITEPA 2003).

Transfer of employer’s NIC liability

Since 2000, employers have, with employees’ agreement, been able to arrange for employees to bear Class 1 employer’s NIC on share options. This has been extended to cover restricted securities and convertible securities.

However, in relation to employees who are not ordinarily resident in the UK, this transfer is not possible (see Paragraph 3A, Schedule 1 Social Security Contributions and Benefits Act 1992).

There seems to be no reason why employers can transfer the NIC liability for UK residents but not in relation to employees who are not ordinarily resident in the UK. This may discourage grants to these employees as all share based awards can give rise to uncertain and uncapped employer’s NICs.